Warning: Get Your Money Out Of Bond Funds

Whenever I constructed a “difficult to sell” muni deal, I could count on the Rochester Family of Funds[Oppenheimer’s Rochester muni fund complex] to buy the deal if there was some “juice” in the yield. After all its other peoples money right? – an email from a multi-decade muni bond professional to IRD this a.m.

IRD warned about Oppenheimer’s exposure to Puerto Rico in July 2015

Puerto Rico officially filed bankruptcy and it appears that Oppenheimer Funds will be taking it on the chin to the tune of at least $2.1 billion in losses. Oppenheimer was the biggest bagholder of PR bonds. In July 2015, Investment Research Dynamics issued this warning about leaving money in Oppenheimer bond funds:

The Oppenheimer Funds mutual fund complex is the largest bagholder of Puerto Rico’s debt. including $4.4 billion of uninsured bonds. Not including tobacco bonds, insured debt and pre-funded bonds, as much as 13% of some of Oppenheimer’s bond funds’ total holding holdings are in Puerto Rico bonds. – Oppenheimer Will Be A Bagholder

The Wall St Journal reported today that the “estimated” losses for mutual funds on PR bonds to be $5.4 billion, of which Oppenheimer’s estimated losses represent at least $2.1 billion, or 38% of the total estimated losses.

“Estimate” in this case is a guesstimate based on what’s been put on the table so far and based on the assumption that the current restructuring proposal will occur and that the new securities issued will maintain their “at issue” value. As a former junk market professional specializing in special situations like this, I can say with certainty that the Wall Street Journal’s estimate of losses will end up being on the low side.

The July 2015 warning about Oppenheimer’s bond funds applies to ALL bond funds except perhaps short term U.S. Treasury bond funds, if you can verify that the specific fund you hold is free from any derivatives exposure – a proposition that is, at best, “iffy.”

I don’t know when the next financial crisis is going hit the markets but, when it does, the damage that will be inflicted on the stock and bond markets will dwarf what occurred in 2008. That’s just one risk faced by bond funds.

Eventually the Fed will lose control of its ability to keep a lid on the short end of the Treasury curve. Short term interest rates will correct rapidly by shooting up several hundred basis points in a price-discovery “correction” that will factor in the real rate of inflation (not the rigged CPI) and the real risk of default by the U.S. Government. In this context default is defined as either the halting of payments on U.S. Treasuries or, more likely, the “de facto” default that is implied when the Government has to print money in order to make the interest and principal payments. When this “price discovery” event occurs, the value of all bond funds will plummet.

The message here is that it is time to get your money out of fixed income and equity mutual funds. The risks embedded in these funds are not worth the probability of incurring a massive hit to your wealth that is held in mutual funds. Eventually these funds will be “gated,” which will prevent you from withdrawing your money.

Look at it this way with regard to your bond funds: you are not earning enough interest on them to make a difference in your lifestyle, so why bother taking on the high risk of a big hit to your invested capital. Currently, you should be concerned about the return of your money as opposed to the return on your money.